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Heirs need to look at fair market value

John R. Bullis

Well, it happened again. A woman died in Aug., 2010 but the heirs prepared their own form 1041 Income Tax Return of Estates and Trusts. The heirs used the original cost of many years before death when they should have used the fair market value at date of death.

The form 1041 they prepared showed big capital gains for the four beneficiaries to be taxed on (since they got distributions that year). The correct answer is instead of each of them being taxed on about $60,000 of capital gains, they should each only be taxed on about $10,000 or so.

The tax rule on getting the “step up” in tax basis to fair market value at the date of death is great.

Congress is dragging its feet again on getting the tax rules for 2014 returns set. Just don’t tell it about the wonderful step up in tax basis at death. Much of those gains are really just the result of inflation. The value may not have increased much in actual purchasing power, inflation caused the price to be adjusted up. Remember when hamburgers only cost 50 cents?

For example, suppose a condo was purchased for about $50,000 many years ago, but the value at date of death was about $190,000. That means the tax basis to the heirs is $190,000 and the possible gain on sale is low if any. The $190,000 is used for figuring depreciation deductions if the condo is rented. That results in more depreciation expense than if they used the $50,000 tax basis.

I remember a couple who owned a ranch they considered selling for about $5 million. They bought the ranch about 40 years ago. Their cost tax basis was only about $40,000. We pointed out they could sell now, pay tax on the gain of maybe $4,960,000, or they could continue to hold the property until one of them died. Since they were both age 84, the tax savings of holding until one of them died (and the survivor getting the step up in tax basis to fair market value then) were great. They decided to just rent it out until one of them died to save about $740,000 in taxes.

When someone dies owning capital assets (real estate, stocks, bonds, etc), be sure to get appraisals or evidence of fair market value as of the date of death. Appraisers can determine real estate value years after death if necessary. If the stocks are held in a broker account, the broker can do a list of fair market values as of date of death for each of the items in the account.

Don’t forget to look at state income taxes. For example, in the condo example above, it was not in Nevada. Especially California state income taxes can be significant.

Did you hear? “Don’t tell anyone the sky is the limit when there are footsteps on the moon.”

John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.